How Things Work

Like science, movie trivia, and hitting a curveball, investing knowledge is supposed to be cumulative. All of us, in other words, have opportunity to benefit from those who have already learned — and taught — how things work.

“You must weigh not only the alluring probabilities of being right, but the dire consequences of being wrong.” – Blaise Pascal

That’s why fixed income investments took further pounding last week when the Fed announced it was not only lifting the federal funds rate, but would likely raise short-term rates another three times next year. Practiced investors know that when interest rates go up, bond prices go down. That’s how the market works.

“We can never know the future — least of all at the very moments when it seems most certain.” – Peter Bernstein

Yet, somehow, in the midst of all this informed behavior, a certain class of municipal bond funds, specifically those of the leveraged closed-end sort, actually went up. Indeed, the 159 such funds (who knew?) collectively gained an average of 0.3% when the overall bond market fell by nearly 0.5%. “Why?” a conversant observer might ask. Best answer is this little amped-up pool of tax frees was annihilated a month ago, and frantic bond buyers were tempted by the leveraged portfolios’ cheap price. That’s how greed works.

“The investor’s chief problem — and even his worst enemy — is likely to be himself.” – Benjamin Graham

History, of course, has shown us time and again that cheap is a relative thing, and it’s not too hard to imagine these funds taking another header as irrational demand dries up. The past has also shown us how just a few months of a bear market can wipe out all the gains we’ve piled up over years of bull markets. All of which should remind us of another Bernstein admonition: “Wealth is a loan — not a gift — from the markets.” That’s how intelligent investing works.

What the markets have been doing…

Despite backing up a bit in reaction to the Fed’s widely-anticipated decision to raise rates, all of the big equity benchmarks ended impressively higher for the two-week stretch. Along with technology stocks, which regained significant traction over the period, value-oriented issues maintained their substantial lead over growth shares in the post-election rally.

Also worth noting was strength in the energy sector. Oil prices jumped Monday morning following the agreement of several non-OPEC oil producers over the weekend to cut production. A strengthening U.S. dollar and rising U.S. oil inventories put pressure on the commodity toward week’s end.

Index

Friday’s Close

Two-Week Point Change

Year-to-Date Change

DJIA

19843.41

+672.99

+13.88%

S&P 500

2258.07

+66.12

+10.48%

NASDAQ

5437.16

+211.51

+8.58%

Unsurprisingly enough, the Fed’s decision to raise rates for only the second time in a decade sparked an increase in longer-term Treasury yields. Following the meeting, the yield on the 10-year Treasury note closed at 2.58%, its highest level since September 2014. Investment-grade corporate bonds were mostly quiet, while the high yield space benefited from several new deals in the energy sector. Municipal bonds were caught up in the post-FOMC announcement selling but managed to hold their ground relatively well.

Fixed Income

Yield

Two-Week Yield Change

2-Year Treasury

1.23%

+0.12%

10-Year Treasury

2.55%

+0.18%

30-Year Treasury

3.12%

+0.08%

30-Year Municipal Bonds

3.21%

-0.06%

It’s all relative…

Changes in investor psychology and subsequent repositioning could make for an interesting active management environment

Quote of the Week…

“Donald Trump is throwing you your first lifeline in a decade.” – Nicholas Colas, chief market strategist at Convergex, speaking about active managers

Number of the Week…

31%

The rise in Goldman Sachs stock since Election Day, the top-performing component of the Dow Jones Industrial Average, accounting for about a quarter of the index’s rise.

What Fund Architects has been doing…

So, the postelection rally continues in equities as does the broad selloff in bond prices, particularly U.S. Treasuries. For our part, we’ve mostly welcomed this dramatic shift in the financial markets. Our strategy is designed to capture upside opportunities in top performing sectors – the very kind of selectivity that’s growing in importance as markets become more dynamic and divergent.

Here at mid-December, the trades we effected at the beginning of the month are performing well. In the Global ETF Model is benefiting nicely from our moves to U.S. Mid Cap equities (MDY) and Global Industrials (EXI). We’re pleased, too, with our fixed income allocation, where we exchanged Convertible Bonds this month for cash. Our move back in November from Treasuries to Bank Loans, which have very little interest rate exposure, has done much to cushion client accounts in this dangerous interest rate environment.

The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.